"Why Cheap Oil is Here to Stay"

Phew! I was actually getting a little worried there writing those posts about oil supply. But I guess I shouldn't have bothered my fluffy little head, because CNN is here to reassure me that everything is going to be just fine.  Peachy.  Future's so bright, we've gotta wear shades.  Here is the official word from the most trusted brand in cable television:

Because oil prices have always been directly related to the strength of the economy, a recovery might have seen headlines like these:

• The recession ends: Get ready for $100 oil

• The economy roars: $140 oil, is there an end in sight?

• Everyone in China buys a Cadillac: World tapped out

But a growing number of experts are saying that you can forget all that. For the next couple of years, they say, oil prices will remain well below $100 a barrel as the economy remains fragile and efficiency measures kick in.

Wait a minute? "For the next couple of years"? "well below $100 a barrel"? That's kind of a pretty big walkback from the headline of "Why Cheap Oil is Here to Stay" isn't it?  More like "Oil: Not Outrageous Again Just Yet". I don't actually disagree that oil could stay at least somewhat below $100 for as long as two years.  But much after that, and forget it. So the headline is not at all helpful: "Why Cheap Oil is Here to Stay" is sensationalist bullshit and CNN should be ashamed of themselves.

Drilling down into the piece, there are a couple of dubious arguments, but let me just take on one in the interests of time:

It's this "becoming more efficient" idea that the Deutsche Bank analysts use to predict even lower oil prices in 2010 than now - an average of $65 a barrel next year compared to nearly $80 currently.

Assuming that Deutsche Bank is saying this (I don't have the report) then they don't know what they are talking about. They have no idea whether oil prices will be somewhat higher or somewhat lower next year, because in reality it's up to King Abdullah bin Abdul Aziz Al Saud, and Deutsche Bank doesn't know what he will do any more than I do.

To make this point, let's look at a historical situation in which Saudi Arabia could not control the price of oil on the downside. This next graph shows the long-term price-production graph for Saudi production (BP data from 1965-2008).

Look what happened in the 1980s.  They reduced production by over six million barrels/day -- almost two thirds of their capacity was shut-in -- and they still couldn't stop prices from eventually falling from almost $100 to $25 (in 2008 dollars).  From the peak price, their revenues fell a factor of around 10!

By contrast, looking at the short term monthly data I posted last week,

Spot oil price versus Saudi Arabian oil supply, 2001-2009.  Source: Supply is an index constructed from EIA, IEA, JODI, and O&GJ estimates. Price is spot price of West Texas Intermediate according to EIA , adjusted for inflation using the CPI to Jan 2008 dollars.

In late 2008, they only had to shut in about 1.5 million barrels a day to arrest the fall of prices, which got down almost to $40, but then recovered to around $70.

In other words, they reasserted control over prices on the downside with a move that was less than a quarter in size than what they had to do in the early 1980s.

What would happen if they shut in another 1.5mbd?  I think oil prices would go up a lot.  What would happen if they immediately restored that 1.5mbd of production - and maybe a little more if they have it now?  I think oil prices would fall a lot.

What will they do?  I have no idea!  If I had to guess, I would guess they'll keep prices somewhere around where they are now, but really I have no clue.  Does Deutsche Bank know?  Of course they don't.